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Feature Article, January 2005
Investors Ride The Net Lease Wave
Industry experts discuss how the triple net leasing market has become such an attractive market for a multitude of investors.
Lara Fuller
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A Jiffy Lube deal by SilverWillis Investment Real Estate.
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After enduring several years in a dragging economy, the triple net leasing market is pulling out of the slump, with the future looking exceedingly bright. In most areas of the country, demand for product outweighs supply, keeping cap rates low. Even with the predicted increase in interest rates, the market will remain energized. As investors continue to look for a safer investment than the often unpredictable stock market, many are leaning toward net-leased properties. Shopping Center Business recently spoke with several companies that are active in the NNN market to get a wrap-up of 2004 and see what is on the horizon for 2005.
2004 vs. Past Years
The economy continued its upward swing in 2004, with a steady increase in demand for properties. A growing number of people are looking for the same type of investment property, one that offers minimal management and a safer investment for their money. The desire for NNN property is outpacing the available supply. The lack of large amounts of net leased product has also pushed prices upward. “There was definitely more demand in 2004 than in prior years and prices were also higher,” says Jay Bastian, senior vice president with Commercial Net Lease Realty. “The challenge in 2004 was selecting the right buyer since many times there were multiple offers and you wanted to select the buyer that could actually close.”
Paul Domb, asset manager with United Trust Fund, takes a similar view. “There were three trends driving the net lease market in 2004: low interest rates, increased competition and tax-free exchange buyers,” he says. “The effect of these factors was that there were record prices in all net leased asset classes and low cap rates. Also, buyers are settling for sub-standard transactions and credit quality because demand exceeds supply.”
According to Barry Silver, owner/partner with SilverWillis Investment Real Estate, lack of product has also halted the growth of some retailers. “There have been limited retailers expanding during the past year,” he says. “With the abundance of capital and the short supply of product, owners who would ordinarily hold their properties have become aggressive sellers, taking advantage of the low cap rates.”
Increased demand for product can be traced to several causes. The first is that more and more investors are getting older, and as they have managed residential properties for most of their lives, they are beginning to look elsewhere, says Ralph Bunje, Jr., president of Independent Exchange Services and Reverse Exchange Services. In addition, the 55-plus age group needs cash flow with minimal management. “Many have large capital gains locked up in residential properties whose prices have exploded in many areas of the country due to lack of supply and low interest rates,” says Bunje. “Returns on equity from rents amount to less that 3 percent cash on cash.” Another factor is that many people are becoming more familiar with Section 1031 exchanges. “Rather than selling for cash and paying their taxes to invest in low dividend or interest bearing securities, they are moving into the NNN marketplace in larger numbers than in any year I have been in practice,” Bunje adds.
Wanted: Drug Stores and Restaurants
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Restaurants, such as this Buffalo Wild Wings (SilverWillis Investment Real Estate), are in high demand for NNN deals.
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With such dynamic market conditions right now, there has been an increase in activity across many property types, though some remain more popular than others. Drug stores are at the top of many investors’ hot lists, with restaurants not far behind. “Drug stores are still very hot, particularly Walgreens,” says Bastian. “Walgreens is the benchmark from which everything else in the $2 million to $5 million price range is evaluated and priced.” Silver agrees, adding, “Walgreens continues to be a hot item. Several Eckerd drug stores are on the market, most without corporate guaranty from CVS or Jean Coutu Group.”
Restaurants are also a popular investment, particularly for those looking to invest a little less. “Restaurants are the investment of choice for the lower price range, even down to small four-store franchisees,” says Bastian.
Silver has also seen the popularity of the restaurant property among investors. “Restaurants have been the most dynamic property type,” says Silver. “Multiple properties leased to Jack in the Box, O’Charley’s, Applebee’s, Arby’s, Sonic, Buffalo Wild Wings, IHOP and Krispy Kreme have been active markets. Interestingly, franchise credit is selling at aggressive cap rates.”
In the million-dollar price range, Dollar Stores, Dollar General and Family Dollar are all in demand, according to Bastian. Below that, in the $300,000 range, tenant-in-common properties (TICs) are very popular.
Bunje has come to a similar conclusion in regards to the attractiveness of the TIC industry for those looking at a lower price range. “The rise of the TIC industry to give a managed investment similar to individual NNN properties have become quite popular as well, since they allow for a diversified tenant base and the ability to buy into a piece of larger product. Exchangers are moving towards these because a lack of good NNN product in their price ranges on the market.”
And while these particular property types are doing well, Domb believes that virtually every property type can do well with market conditions favorable as they are. “There is no single hot property type,” says Domb. “The market is red-hot and if you have an iceberg with good enough credit, there is someone to buy it and lease it back.”
Baby Boomers Keep Buying
The type of person most active in the triple net leasing market tends to come from the same demographic group. Most are baby boomers, around the age of 55, with several years of management experience under their belt. “Most investors in real estate with significant profits to protect through the exchange process appear to be between 40 and 60 years of age,” says Bunje. “Since they are sellers doing an exchange, they are the same people doing the buying.”
“Buyers continue to have the same profile,” says Bastian. “They are aging baby boomers who have owned management intensive real estate, such as apartments, office, small shopping centers or inherited real estate and now they just want to clip coupons.”
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A Barnes & Noble net lease deal by Commercial Net Lease Realty.
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What kinds of deals are these baby boomers looking for? Properties that are priced under $2.5 million, says Bunje. Many are also looking for properties that are less management intensive. In addition, they favor reverse exchanges because of the timing problems involved in a conventional exchange, says Bunje.
“Many deals are being re-traded, i.e., leases in place being sold again and again within a relatively short time frame,” says Domb. “Individuals, REITs and institutional investors realize now is the time to achieve large profits. The most active buyer is the tax free exchange investor versus a decrease in traditional buyers seeking quality investments.”
Aside from the baby boomers, portfolio buyers and developers are also involved in the marketplace. “The most active sellers are portfolio buyers such as CNL, Kimco and RIC,” says Silver. “Other smaller players have acquired portfolios for resale.”
“Developers are the most active sellers,” says Bastian. “Also, some operating companies and portfolio owners who recognize the great time to sell while prices are high.”
What’s In Store For 2005?
The coming year is expected to be busy, busy, busy. The high demand and low supply from 2004 will continue through the year, keeping the market churning at full force. “I believe the market for NNN properties will continue to be highly charged. Interest rates will probably increase, but not drastically, during the coming year,” says Silver. “We are looking at another very busy year.”
“The demand will remain through 2005 because of the continuing demographic trends of the buyer pool, the continued uncertainty of the stock market and the continued interest in deferring capital gains taxes,” says Bastian.
One cloud in the sky of the future market, however, is the potential for increased interest rates. “I expect the market to remain hot until there is an anticipated rise in long term interest rates,” says Bunje.
Domb agrees. “The competitive market will continue as is until interest rates rise,” he says. “Good deals will be done but they will be sporadic. Corporations may view an up-tick in interest rates as a knee-jerk, last-opportunity reaction to take advantage of a favorable market for tenants seeking sale-leaseback financing.”
Adds Bunje, “Long term single tenant NNN leased properties should normally sell at cap rates between 8.5 percent and 10 percent. Cap rates between 6 percent and 7.5 percent, which seems to be the norm today on long term tenant favorable leases, will be a disaster should there be a return to higher interest rates or another run of inflation. Should we enter into a deflationary spiral, which a minority of economists are predicting, then these investments should hold their own. A declining dollar is another source of hidden inflation that could hurt these types of investments.”
©2005 France Publications, Inc. Duplication or reproduction of this article not permitted without authorization from France Publications, Inc. For information on reprints of this article contact Barbara Sherer at (630) 554-6054.
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